Bill Woolsey has a newer post in which he discusses his reasoning in supporting the “Audit the Fed” bill introduced by Rand Paul. He also goes through some reasons why he found it somewhat uncomfortable to do so, calling its supporters “crazies” who won’t be satisfied by the audit anyway.
Last August I included a brief analysis of H.R. 5018 Federal Reserve Accountability and Transparency Act in a post about the same. It is not the same bill as the one introduced in the Senate by Rand Paul, which I have not yet read, but I believe they are similar as 5018 includes a provision for auditing open market operations and other such monetary activities.
In his post Woolsey states as a reason for his support of the audit bill concerning bailouts thusly:
Of course, after the Fed got into the business of making loans to particular banks and other financial firms in big way in 2008 and 2009, an audit became especially justified. Who was bailed out and why? This is government money. Should central bank officials know that they will have to justify their decisions later? Yes, of course. Will this make them more cautious in an emergency? Most likely. Should they be more cautious because they understand that their decisions will be subject to “Monday morning quarterbacking?” Yes. It is much better than the alternative of bailouts with no accountability.
I agree with Woolsey’s reasoning. Congress should know who got bailed out and why. But what I see as an oversight in his reasoning is the counterfactual that loss of accountability occurred well before there was a need to bail out financial institutions that resulted in that need. The focus on the bailouts is only secondary to a much larger problem of policy drift from mandates, something I hinted at here in a post about the politics behind the adoption of an inflation targeting regime that started in 2006.
The law delegating monetary policy to the Federal Reserve, The Federal Reserve Act as amended by The Full Employment and Balanced Growth Act states that it is to manage monetary and credit aggregates commensurate with the economy’s long run ability to increase production so as to promote full employment, stable prices and moderate long term interest rates. Strict, explicit inflation targeting does only one of these, and cannot not do all of them (Sumner, Woolsey (just to point out a few)). And as in the commentary on the effects inflation targeting has on prices, there very little room left for doubt that the bailouts were an implicit effect of a similar policy.
Supposing that only the bailout audit portion of the bill would become law, without deference to some standard yardstick to measure the performance of monetary policy in general and a policy such as the one adopted circa 2006 came into effect, a likely result of the induced caution would be that nobody or very few would be bailed out which would be the equivalent of the Fed’s refusal to execute on its lender of last resort function as in the 1930’s.
In early 2008, Bernanke arranged for a sort of bailout of Bear Sterns and Merill Lynch for which he was promptly summoned before Congress to explain himself after the CEO of Bank of America, the firm that assumed ownership of Merill Lynch, complained BoA got a lousy deal while lobbing accusations of graft. I don’t have any hard evidence that this had a cooling effect on Bernanke’s willingness to further engage in similar activities, but these were last of Bernanke’s direct involvement in any rescue operations. And as we know, Lehman was allowed to fail.
And the cumulative effect of the audit therefore would be unlimited ability to create a monetary atmosphere conducive to bailouts without the impetus to alleviate the need.
Woolsey expands on his support of the audit to limit discretionary monetary policy:
And finally, I fully support having the Fed’s monetary policy actions reviewed. Should Fed officials understand that they will have to justify what they have done? Yes, of course. Might the need to do so make them more cautious? Yes. Might that result in some errors where a Fed that was less accountable would take an appropriate action? Maybe. And, of course, it might also avoid other errors due to irresponsibility. More importantly, it is better than the “rule” of no accountability.
To me, this is the most important – prevent monetary policy from creating a bailout atmosphere by insisting upon adoption of rules that are mostly likely to achieve and maintain nominal stability in most circumstances and be held accountable for execution of those rules. If Congress passes a bill that audits the Fed without insisting on general accountability to the mandates, I fear that the next Great Recession will actually become the Great Depression redux. If it does not do accountability for the mandates, I would prefer it do nothing.
PS: In the great scheme of things, the most critical factor in reforming governance of the Federal Reserve is doing no greater harm. If we as a society cannot come up with some sort of agreement on formal expectations for the general conduct of monetary policy, we cannot forget that the high level concern should be to prevent humanitarian and moral monetary calamities such as those that came with the Great Depression, and to a lesser degree with the Great Recession. And in my point of view, accepting that bailouts arising from the chaos of a disinflation are sloppy affairs is not entirely unreasonable considering the implications of not doing so. If there’s a need, open the spigot – I don’t even particularly care where it lands as long as it prevents average people losing everything they have on a grand scale.